Compensation consultant McLagan and management consultant Casey, Quirk & Associates say in their whitepaper that asset management company operating profits are likely to decline by an average of 35% in 2008, and could see a further decline of 35% in 2009, if expenses are not reduced.

For 2008, the consultants assume all operating expenses will be in line with 2007 levels, except for cash bonuses and long-term incentive grants, which they estimate will be cut by 25%. For 2009, the consultants assume there will be 20% expense reductions in discretionary operating expenses, such as marketing, technology, and travel and entertainment. The report said pay practices are more difficult to predict as some firms are more likely to focus on cutting headcount, while others are more likely to focus on reducing bonus pools.

According to the whitepaper, changes in compensation and benefits—the largest expenses for asset management companies, usually accounting for 40-60% of revenues —have the greatest impact on profitability. The consultants modeled potential tradeoffs between reductions in incentive compensation and reductions in headcount and found that if headcount and incentive spend remained flat between 2008 and 2009, then operating profit margins would decline by over 5%, from an average of about 28% of net revenues in 2008 to 22% of net revenues in 2009.

To restore 2009 profit margins to 2008 levels through compensation-related spending cuts, the report said, the average firm will likely have to slash incentive spending by more than 20% and headcount by more than 10%. In addition, the consultants said they believe further industry layoffs will be required, and in many firms, these cuts will be added to, and far exceed, the 10% staffing reductions that already started during the fourth quarter of 2008.Specialty equity-oriented firms are likely to see the worst top-line compression, the consultants anticipate, with their revenues potentially falling by 40% between 2007 and 2009. Their average operating profit margins could drop from 39% in 2007 to 18% in 2009.

Not all firms will endure the same financial pressure during the adverse market, according to the report, “Crisis in Asset Management: Industry Profitability Under Siege.” Equity-focused firms will be under greater pressure than fixed income-focused firms, and mutual fund-focused firms could face the “double whammy” of declining markets and significant redemptions from retail investors, the report said.

The consultants forecast that the revenues of the more globalized firms, which typically have the most diversified business and product mix, will decline the least, sliding about 25% between 2007 and 2009. Meanwhile, the report said multi-capability firms, which offer a broad product array and serve multiple distribution channels but are not yet global, will suffer the most financial pressure.

Typically carrying the burdens of subscale products, distribution or both, these firms already have operating profit margins that trailed industry norms, and without significant reduction in compensation and benefit expense, the consultants anticipate these firms’ operating profit margins will decline from 25% in 2007 to 13% in 2009.